Treasuries are gaining lost ground for the third consecutive trading day. This represents the longest stretch of improvements in December thus far. The benchmark 10-year yield is down another 6.8bps at 3.27%. The Fannie Mae 4.5 MBS coupon is +11/32 at 102-11.

From AQ's MBS close on Friday....

December floaters shouldn't be comfortable yet. You should actually be pretty antsy. That's how the market will behave next week at least. The week ahead will be defined by Christmas parties, hangover headaches, out of office replies and a straight up lack of trading liquidity (can it dry up anymore???) That means the potential for price chopatility is high.

Now. That isn't necessarily a bad thing. Volatility was very friendly to our cause on Thursday and Friday. But December floaters should still be pretty antsy. Especially if 4.75% is on the table. 4.75% is good stuff right now. Even if rates do rally next week, it's year end for lenders too. They probably won't get too aggressive with their hedging strategies. Not with February FNCL 4.0s indicated at 98-13. Thus the Fannie 4.5 is expected hold the production coupon title belt at least into the early part of the new year. That means lenders will probably draw a line in the sand at 4.75% (via expensive permanent rate buydowns).

Key Events in the Week Ahead

Monday:

No headline data. 

10:15 ― Fed buys $7-9 billion in TSYs maturing between 2/15/2018 and 11/15/2020

1:15 ― Fed buys $6-8 billion in TSYs maturing between 12/31/2014 and 5/31/2016

Tuesday:

No headline data.

10:15 ― Fed buys $7-9 billion in TSYs maturing between 6/30/2016 and 11/30/2017

1:15 ― Fed buys $1-2 billion in TSYs (TIPS) maturing between 7/15/2012 and 2/15/2040

Wednesday:

7:00 ― The weekly MBA Mortgage Applications last fell 2.3% as refinancings dropped for their fifth straight week and purchases declined 5%. Overall purchases were down 16.6% from the same week last year. As the average rate for a 30-year fixed-rate mortgage increased to 4.84% from 4.66%, it seems unlikely application volumes will surge anytime soon.

8:30 ― Revisions are expected to boost third-quarter GDP by three tenths to an annual growth rate of 2.8%. This is the second set of revisions; the original projection for third-quarter GDP on Oct. 29 was just 2%. As we head into 2011, the real focus is on fourth-quarter figures and what that means for 2011. Fortunately, the third-quarter revisions are set to rise in large part because of inventory accumulation, which indicates that businesses were expecting a pickup in demand.

“Sometimes faster inventory accumulation is a bad signal for future growth, but recent evidence on demand has been coming in strong, suggesting that these inventories are desired, rather than unwanted,” said economists at IHS Global Insight. “At this point, fourth-quarter growth is shaping up at over 3%, better than the revised third quarter.”

10:00 ― Existing Home Sales are anticipated to climb 5% to an annualized rate of 4.71 million in November, up from 4.43 million in October. The expected gain is based largely on a 10.4% jump in the pending home sales index, which anticipates existing home sales by a month or two. Last month, existing home sales fell 2.2%, with sales down in all four regions despite prices down 0.9% compared to last year. 

“Existing home sales have made some headway since collapsing in July,” said economists at IHS Global Insight. “For November, we are expecting a pickup to a 4.66 million annual rate, based on October's 10.4% increase in the Pending Home Sales Index, and November's 7.7% increase in the MBA's Purchase Index.”

10:15 ― Fed buys $1.5-2.5 billion in TSYs maturing between 2/15/2021 and 11/15/2027

Thursday:

8:30 ― Durable Goods Orders are expected to fall 0.4% in November, subtracting from the -3.4% print a month before. Expectations range widely, from -3.6% to +3%. One reason for the expected decline is a sharp drop in Boeing aircraft orders. Excluding transportation, orders are forecast to be up 1.6%, compared with a 2.7% drop the month before. Core durable goods ― non-defense orders excluding aircraft ― should rise 2.5% in the month after a 4.3% cutback in October.

“Non-defense aircraft and parts has been either feast or famine for the past two years, and September and October were feasts and November was a famine,” said economists at IHS Global Insight. “Aircraft orders should slump from about $13 billion per month in September and October, as November comes up short at about $5.5 billion. Even the rebound in machinery orders after a dismal October, which should push core capital goods orders up 5.0%, and a rebound in defense bookings can't offset the downdraft in aviation on the total.” 

8:30 ― The Personal Incomes & Outlays report is anticipated to show incomes rising slowly and consumption rising a bit more rapidly amid mild inflation. Income is forecast to rise 0.2% in November, adding to the 0.5% gain a month before. Consumption is set to move up 0.5% after a 0.4% gain. Core inflation ― the Fed’s preferred measure ― is anticipated to rise 0.1% in the month after a flat reading in October, which would leave the annual rate at just +0.9%, far below the optimal 2% pace.

“U.S. retail sales in November increased by 0.8% and reached a level of 7.7% above its November 2009 level,” noted economists at BBVA. “Total sales in the last three months jumped 7.8% from the same period a year ago. Retail sales excluding autos also increased by 1.2%, above expectations of a 0.6% increase. ... Therefore, we expect personal income and spending to continue increasing in November.”

“Overall,” added economists from IHS Global Insight, “real consumer spending is heading for a 3.5% increase in the fourth quarter; significantly higher than the third quarter's 2.8%, which was the strongest since late 2006 in seasonally adjusted annual rate (SAAR) terms.”

8:30 ― The four-week average of Initial Jobless Claims has declined for six consecutive weeks and currently stands at just 422,750 ― the lowest since early August 2008). For the week ending Dec. 18, economists are anticipating 420k claims, the same figure as the prior week.

“This continued fall signals a gradually improving labor market,” said economists at Nomura. “Because this week's report will reflect job conditions during the 12 December reference week for the official employment report, another low reading on initial claims could raise market expectations for December nonfarm payrolls.”

Economists at BBVA pointed out that initial claims remain higher than pre-recession levels, however, suggesting the recovery remains slow.

9:55 ― Holiday spirit isn’t expected to have much impact on Consumer Sentiment in December. The Reuters / U of Michigan index is anticipated to rise six-tenths from the preliminary reading to 74.8, with expectations ranging from 73 to 77. The preliminary index did, however, advance 2.6 points to the highest level since June. The economic conditions component increased to 85.7, while the economic outlook component moved up to 66.8.

Economists at IHS Global Insight said the preliminary reading was “good news for retailers, since an increase in consumer optimism translates into relatively good news for holiday sales.” They predicted that holiday retail sales would be up 4.5% compared to last year.

“Gains in household net worth due to the rising stock market and relatively good news on the employment front should drive the recent momentum in consumer sentiment slightly higher, despite higher gasoline prices and a poor housing market,” they added.

10:00 ― New Home Sales nosedived 8.1% to an annualized pace of 283k sales in November ― the second lowest figure on records dating back to 1963. The unexpected fall came after two increases and was further hurt by downward revisions to the prior three months of data. For November, economists look for an increase to 300k, a pace well below the historical average of 697k, according to BBVA.

“Considering current inventories in the housing markets, we expect new home sales remain weak even in 2011,” they added.

Other economists point to improvements based on November’s increase in single-family housing permits, an improving job market, and a pick-up in MBA’s index of mortgage purchase applications. 

Friday:

All Markets Closed. Merry Christmas!